HELOC Vs. Personal Loan: Compare And Choose

Do you want to consolidate debt, pay for a home improvement project or maybe even start a business? Both home equity lines of credit (HELOCs) and personal loans allow you to use the proceeds for whatever purpose you need. But which is right for you? We’ll go over the differences between a HELOC versus a personal loan, and discuss the alternatives.

Rocket Mortgage^® doesn’t offer HELOCs at this time, but we do offer Home Equity Loans¹ as an alternative. Our friends at Rocket Loans℠ offer personal loans.

HELOC Vs. Personal Loan: Key Differences

While we’ll go deeper on HELOCs and personal loans throughout the article, let’s go over some of the top-line differences at a glance below:

How Does A Home Equity Line Of Credit (HELOC) Work?

A HELOC is a line of credit that uses your house as collateral. You’re approved for a given amount based on your financial qualifications and the value of your home. It’s possible to get a first-lien HELOC, but most often they’re offered in addition to your primary mortgage.

The interest rate would be slightly higher than your first mortgage because the initial lender gets paid first if you default. But it would be lower than a personal loan because the home is the security for the loan.

HELOCs have a draw period at the beginning of the loan. During this time, you can access the funds and the only payments you’re required to make are on the interest of your drawn funds. You can also replenish funds to access them again. Sometime later, the balance freezes during a repayment period and you pay both principal and interest for the remainder of the term.

The terms may vary by lender, but a HELOC, for example, might have a 10-year draw period followed by a 20-year repayment period. It’s also notable that rates tend to be variable on these because the balance changes every month like a credit card.

How Does A Personal Loan Work?

Personal loans don’t require collateral as you’re approved entirely on a lender’s judgment of your creditworthiness. However, because there’s nothing for a lender to take back if you default, interest rates are higher than they would be for a HELOC. On the plus side, interest rates tend to be fixed. Terms are also shorter and you can borrow less.

Should You Get A HELOC Or A Personal Loan?

If you’re deciding between a HELOC and a personal loan, the right decision is highly dependent on your individual situation. But we can give you some pros and cons that might help you wrap your head around it.

HELOC

Let’s start with benefits and drawbacks of a HELOC.

Pros

• Maximize flexibility: During the draw period, you can take funds out and put them back over and over again if you choose. This could enable you to use your HELOC to accomplish multiple goals.
• Low payments during draw period: Because you only have to make interest payments during the draw period, the required payment is lower up until the point the balance freezes.
• Lower interest rate than personal loan: Because it’s tied to your home, the interest rate is going to be lower than a personal loan would be.

Cons

• Potential for payment shock: Because you’re only required to pay on the interest at the start of the loan, you may find that it creates stress if you’re not prepared when you have to start paying back the principal along with the interest in the second half.
• Variable rates: Because these work like credit cards, the interest rate could swing up quite a bit in a rising rate environment. Of course, they also go down if rates fall, but it’s something to be aware of.
• Temptation to overspend: Because it’s a line of credit, you may not be as worried about sticking to a strict budget. While you can spend up to the full amount, you’ll pay more in interest and principal.
• Closing costs: The closing costs associated with this are going to be in the range of a refinance, 3% – 6% of the loan amount. That may not be something you want to deal with if you don’t have cash on hand.

Personal Loan

Now let’s do a breakdown of the advantages and disadvantages of personal loans.

Pros

• No collateral: By getting a personal loan, you’re not putting your house at risk if you default. This also means not having to wait for an appraisal or hope it comes in at a certain value.
• Quick funding and approval: Depending on the lender and your bank, you could receive funding as quickly as the same day.
• Fixed rates: Rates are fixed, so you don’t have to deal with changes.

Cons

• Higher rates: Because the lender has no way to recoup their investment if you don’t make the payments, the interest rate is going to be higher than it would be with a HELOC.
• Shorter terms: You could consider this an advantage or disadvantage, but it does mean the monthly payments will be higher than options with a longer term.
• Stricter qualification standards: If you’re being approved solely on your own personal creditworthiness, you’ll need to meet higher standards typically than when there’s collateral involved.

Tips For Choosing A HELOC Or A Personal Loan

If you’re trying to decide between a HELOC and a personal loan, here’s some things to think about.

How Much Do You Need To Borrow?

Borrowing limits for HELOCs are one thing and will vary from lender to lender, but you’ll also be limited in how much equity you can borrow in part depending on the size of your first mortgage. Let’s assume the lender allows you to borrow up to 90% of your equity and you currently owe $300,000 on a house worth $400,000. Here’s the equation:

0.9 × Home Value - Existing Mortgage Balance = Maximum HELOC Amount

When you plug the numbers in, that one comes out to $60,000. The bottom line is you have to know you have enough existing equity to get the job done. If not, that might be one reason to turn to a personal loan or scale back your ambitions.

Do You Have Any Cash On Hand?

If you have cash on hand, you might go with a HELOC because closing costs are often in the range of 3% – 6%. However, that’s not always possible. Origination costs on a personal loan can be higher, but they’re often taken out of the proceeds. You may pay nothing upfront.

When Do You Plan On Selling Your Home?

If you’re considering a HELOC, you may also want to think about when you’re selling your home. You want to make sure that you are in the home long enough that the closing costs on the new one makes sense in a way that you save money in your project vs. taking a personal loan or another alternative.

You should calculate your monthly savings as compared to other options and determine how long you need to stay in the house for it to make sense. If you plan to move before then, it would be best not to touch your equity if you don’t have to.

Alternatives To A HELOC Or Personal Loan

HELOCs and personal loans can be good options depending on what you’re trying to do, but they aren’t the only options available. Let’s go over some alternatives:

• Home equity loan: Home equity loans are second mortgages, but unlike HELOCs, you get a lump-sum payment as opposed to a line of credit. You would take a look at a home equity loan vs. a personal loan if you already have the budget in mind.
• Cash-out refinance: A cash-out refinance is a lump-sum payment like a home equity loan except that instead of taking a second mortgage, you refinance your primary mortgage so that you have one payment. In order to decide between a cash-out refi vs. a HELOC or home equity loan, a Home Loan Expert can help you with a blended rate calculation where they take the weighted average of the loan amounts to see which option saves you the most money
• Credit card: The upside of paying with a credit card is that you can potentially get a 0% introductory annual percentage rate for the first few months which would give you time to pay off the balance and receive funding very quickly. But the poison pill here is that if you don’t pay off the balance, you’re paying the highest interest rates of just about any other option. This is something you have to be very careful with.

The Bottom Line

A HELOC lets you take out a line of credit and then only payback what you use. During the draw period you can replenish the funds as many times as you want to reuse the funds again while only being required to make the interest payments, followed by making principal and interest payments during the repayment period. One of the downsides of this is variable rates.

Personal loans don’t require any collateral and you don’t usually pay closing costs on them. These are deducted from the proceeds. On the downside, qualification can be stricter and interest rates higher because it’s relying only on your personal credit history with no security for the lender.

We don’t offer HELOCs, but our friends at Rocket Loans offer personal loans. If you decide a Home Equity Loan or cash-out refinance is a better way to go, start an application today to consider your options.

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.